Renalta | January 14, 2026
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While some loans are secured by specific assets, like a car for an auto loan, many forms of credit, such as personal loans or credit cards, are unsecured and require no collateral at all. The bank is essentially betting that the borrower’s promise to repay is worth the risk.
When borrowers default, banks face lengthy legal processes to recover funds. Even with collateral, recovery rates are often low after legal fees and asset depreciation.
Overcollateralized lending flips this model entirely. Instead of evaluating creditworthiness, borrowers deposit valuable assets worth significantly more than what they want to borrow.
For example, to borrow $10,000 in stablecoins, a borrower might need to deposit $15,000 worth of other digital assets like Bitcoin or Ethereum. This creates a 150% collateralization ratio, meaning there’s always more value securing the loan than the loan itself.
If the borrower can’t repay or if their collateral value drops too much, the system automatically liquidates (sells) enough collateral to repay the loan.
Contrary to traditional lending, this required no credit checks and no collection agencies. Anybody with access to stablecoins or a digital wallet can access these loans.
Traditional Lending:
Overcollateralized Lending:
This seems counterintuitive. Why would someone deposit $15,000 to borrow $10,000? Several reasons make this attractive:
Tax optimization: Borrowers can access liquidity without selling assets and triggering capital gains taxes
Maintaining exposure: They keep ownership of appreciating assets while accessing cash
Instant approval: No credit checks or lengthy approval processes
Global access: Anyone worldwide can participate without traditional banking relationships
This type of lending requires borrowers to deposit assets valued at 120% to 200% of the loan amount.
A high level of collateral serves as the primary security for the loan. Some may refer to this mode as secured lending. In cases where the borrower cannot repay, the system can automatically liquidate the collateral to cover the debt. There is always built-in protection for the lender.
In traditional lending, bad loans create losses that get passed to depositors through lower interest rates or bank failures requiring government bailouts.
Compare that to overcollateralized lending where there are no “bad loans” in the traditional sense. If a borrower can’t or won’t repay, their collateral automatically covers the debt. The system is designed so depositors never lose principal due to borrower defaults.
This fundamental difference – asset-backed lending versus promise-based lending – is why overcollateralized protocols can offer higher yields to depositors while maintaining safety. The risk profile is simply better when loans are secured by more value than they represent.
The worst-case scenario is that collateral liquidation happens slightly below the loan value; the overcollateralization buffer typically covers these edge cases.
The most common concern about overcollateralized lending involves volatile collateral like Bitcoin. “What if Bitcoin crashes while securing my loan?”
The overcollateralization buffer is specifically designed for this scenario. If someone deposits $15,000 in Bitcoin to borrow $10,000, Bitcoin would need to drop more than 33% before the loan approaches being underwater.
The market design ensures that the system doesn’t wait that long. Auto-liquidation typically triggers when collateral drops to 120% of the loan value. Using our example, if Bitcoin falls from $15,000 to $12,000 (a 20% decline), the system automatically sells enough Bitcoin to repay the loan in full.
The borrower loses money on their Bitcoin investment, but depositors get repaid completely.
Even during the March 2020 crypto crash when Bitcoin dropped 50% in 24 hours, properly designed overcollateralized lending protocols protected depositor funds through automatic liquidation mechanisms.
This is why overcollateralized lending can safely offer higher yields than traditional banking. Code-based systems with a collateral buffer and automatic liquidation can create better protection than credit scores and traditional ‘trust.’
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